Will Metals Crush This Emerging Markets Rally?

A rise in industrial metals prices has spirited emerging market equities to their highest level in more than a year, but this too will fade, Capital Economics says.

The simple reason? The likelihood that metals prices will fall in large part because "we are close to a peak in China’s steel demand" and therefore iron ore demand. In addition, high prices are have notably boosted iron ore output in India.. Here's the logic from Capital Economics in a note today:

" ... the materials sector of the MSCI EM Index of equities closely tracks industrial metals prices. With copper prices now at a 20-month high, and iron ore prices hitting levels not seen since 2014, it is hardly surprising that the sector has performed well recently, boosting the overall MSCI EM Index. However, we do not expect the recent strength of metals prices to last.

Recent gains appear to have been underpinned by excessive optimism about the boost any US fiscal stimulus will provide to the demand for metals, and in some cases, by temporary supply disruptions. In our view, copper and iron ore prices in particular have risen well above what is justified by fundamentals.

If we are right, then stock markets where the materials sector accounts for a particularly large proportion of total market capitalisation are most vulnerable. On this measure, Peru stands out as amongst the most exposed, followed by several of its neighbours ... Chile’s index tends to move even more closely with copper prices than Chart 2 might suggest. Mining plays an important role in the broader economy, but the largest firm, Codelco, is state-owned and therefore unlisted ..."

The leveraged Direxion Daily Gold Miner's Index Bull 3x Shares (NUGT) is up 65% so far this year, while the iShares MSCI All Peru Capped exchange-traded fund (EPU) is up nearly 12%. Brazilian iron ore producer Vale (VALE) is up 48% this year and an eye-popping 304% over the past 12 months. Aluminum Corporation of China (ACH) is up 32% this year, and the iShares MSCI Emerging Markets ETF (EEM) is up more than 9% this year.

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